Publication: Eurasia Daily Monitor Volume: 4 Issue: 76

Novatek, Russia’s second-largest natural gas producer, has long been seen as the country’s major independent gas player. However, earlier this month Novatek took another step toward further cooperation with state-controlled gas giant Gazprom by taking part as a proxy in a controversial auction to sell assets of the insolvent Yukos company.

EniNeftegaz, an Eni-Enel consortium, placed a winning bid of 151.54 billion rubles ($5.85 billion) for the lot, which included Yukos’ 20% stake in GazpromNeft and two gas production units, ArcticGaz and Urengoil. An unknown company, Unitex, reported to be fronting for Novatek, withdrew after just two bids, leaving EniNeftegaz and Rosneft subsidiary NeftTradeGroup to contest Yukos assets by themselves on April 4.

Novatek appeared to take part in the auction in order to give it a semblance of legitimacy, Kommersant-Dengi weekly commented. The lack of true competition allowed bidders to acquire valuable assets at a low price (Kommersant-Dengi, April 9).

In the wake of the auction, Eni announced plans to pass on the bulk of the Yukos assets to Gazprom. The GazpromNeft stake would be entirely transferred to Eni, which has given Gazprom a call option to buy the stake for $3.7 billion within two years.

Before the auction, Gazprom insisted it had no interest in it, but the gas giant was understood to prefer to rely on a proxy firm to snag the assets. Subsequently, EniNeftegaz gave Gazprom the option of buying a 51% stake in ArcticGaz and Urengoil within two years. “We will receive at least 51% of the assets,” Gazprom deputy head Alexander Medvedev said after the auction (RIA-Novosti, April 5).

Gazprom and Italy’s oil major, Eni, have a history of close cooperation. In November 2006, Gazprom and Eni signed an agreement allowing Gazprom to sell gas directly to Italy and extending supply contracts to 2035. The two companies also agreed to allow Gazprom to enter the production assets and downstream gas operations of Eni, in exchange for Eni having a stake in Russian production assets.

Gazprom has indicated that the call option agreements for the 20% Gazprom Neft stake and 51% stakes in ArcticGaz and Urengoil were concluded as part of that agreement. Shortly before the Yukos auction, Gazprom CEO Alexei Miller met Eni SpA CEO Paolo Scaroni in Moscow to discuss the bilateral agreement signed on November 14 (Interfax, March 26).

In the wake of its November deal with the Russian gas giant, Eni was also rumored to be mulling acquisition of a 10-20% stake in Novatek. Gazprom currently controls a 19.4% stake in Novatek. Levit LLC and SWGI Growth Fund, controlled by Novatek’s top executives, hold 32.31% and 14.25% respectively. In July 2005, Novatek held an IPO and raised the share of its publicly traded stock from 5.13% to 24.13%.

Novatek owns gas fields are in the Yamalo-Nenets region, the world’s major gas producing area. In 2006, Novatek produced 28.7 billion cubic meters (bcm) of gas, 14% higher than in 2005. Despite strong gas prices, Novatek’s net profit was 14.71% at 12.95 billion rubles ($500 million) in 2006, down from 15.18 billion ($586 million) in 2005.

In September 2004, Novatek announced plans to sell its 25% plus one share stake to Total for some $1 billion. Novatek had expected Total’s acquisition would help it to build a new $1.3 billion petrochemical complex in Novokuibyshevsk, Samara region. However, Russian regulators did not approve the acquisition, and in August 2005 Total decided to pull out of the deal. Therefore, Novatek’s plans to build the Novokuibyshevsk complex remained stalled.

Following the flawed deal with Total, Novatek moved to strengthen ties with Russia’s gas monopoly. In 2005, Novatek signed a strategic cooperation agreement with Gazprom and has been considering the $1 billion Novourengoi gas-chemical complex as an alternative to the Novokuibyshevsk project.

Novatek also moved to cooperate with Gazprom’s subsidiaries. On February 27, 2007, Russia’s petrochemical major Sibur and Novatek agreed to set up a joint venture in Tobolsk to produce some 500,000 tons of polypropylene annually, while Novatek would act as a gas supplier. Sibur, fully owned by Gazprom and its banking unit Gazprombank, would retain a controlling stake in the joint venture.

Novatek was understood to have few viable alternatives to the Russian gas monopoly, as it remained dependent on Gazprom’s network of gas pipelines. Furthermore, in July 2006 Russia adopted new legislation to give Gazprom and its subsidiaries monopoly rights to export all gas from Russia.

Russia has enviable levels of gas reserves, estimated at 29 trillion cubic meters. In 2006, Russia produced 656.3 bcm of gas or 2.4% over 2005, while Gazprom’s share was down to 83.9% from 85.9% in 2005, according to the Russian Industry and Energy Ministry’s data. The ministry estimated an expected 2007 production at 665 bcm, while gas output is expected to go up to 717 bcm in 2010.

Yet despite high production volumes, Gazprom and other producers appear to be struggling to meet all domestic and export demands. In October 2006, the Russian Industry and Energy Ministry said the country could face a natural gas shortage of 4.2 bcm in 2007. Russia’s gas shortage could reach 8.4 bcm in 2008, 27.7 bcm by 2010, and 46.6 bcm by 2015, the ministry said in a report released on October 19.

The Russian government also voiced expectations that alternative producers would raise their combined output, thus limiting the expected natural gas shortages. On April 8 Industry and Energy Minister Viktor Khristenko said that the Russian independent gas producers, notably Novatek, were expected to supply more than half of the country’s industrial needs by 2015.

Novatek executives also pledged to raise gas output, but urged the government to refrain from increasing taxes. Independent gas companies planned to produce 75 bcm of gas by 2010 and 200 bcm by 2020, Novatek’s deputy CEO Mikhail Popov said. However, he warned that higher taxes on natural gas could entail lower output, and Russia then would have to rely increasingly on Central Asian gas imports. Popov also said that some projects would be unprofitable for many gas producers, including Novatek (RIA-Novosti, April 4).

Novatek appears to remain firmly connected with the government’s strategy to develop the natural gas sector. It remains to be seen whether Novatek can manage to become truly independent from the government and Gazprom any time soon.